Just days after the Bank of Israel declared that the country's recession had technically ended, a group of leading California venture capitalists predicted the renaissance of Silicon Wadi, Israel's impressive high-tech sector.

"It's starting to happen in Israel again," said Harry Kellogg, vice chairman of Silicon Valley Bank and president of its merchant banking operation, which has invested in eight Israeli funds so far.

"Last year, about $1.1 billion was invested in Israel, ranking it No. 3 in the world after Silicon Valley and Boston," said Kellogg, who visited Israel last month along with 40 other major California investors. "More money is coming into startups here than is going into Shanghai or India. It's one of the key markets in the world as far as Silicon Valley Bank is concerned," he said.

Despite the optimism of venture capitalists and government banks, there's no denying Israel remains mired in political strife that makes it difficult for the long-standing technology industry to stay strong and grow. Just the same, Israel's tech sector, nurtured from academic and military roots, is showing that it's up to the task, thanks in large part to money coming from U. S. venture capitalists.

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The global economic downturn of the past three years was amplified in Israel by the three-year Palestinian intifada. The impact of continued violence and terror attacks hurt the tourism industry and depressed consumption across the board, sending the gross domestic product plummeting.

"The Israeli economy was essentially mimicking what happened in the United States but with a magnification effect due to the security situation," said Manuel Trajtenberg, an economics professor at Tel Aviv University.

Nevertheless, the American investors visiting Jerusalem said the intifada hurt the high-tech sector less than it did other parts of the Israeli economy. Trajtenberg said figures available so far confirm that impression.

"It is true that the high-tech sector was shielded to a large extent from the magnification effect of the intifada," he said. "If you look at indicators of activity like unemployment, number of workers and exports, the downtrend is similar to the high-tech sector in the United States."

"There was less of a magnification compared to other sectors of the economy like tourism and retail industries," Trajtenberg said.

Last month, the Bank of Israel said that the recession in Israel, which began in the summer of 2000, months before the outbreak of the intifada, ended in November. The central bank said the recession cost Israel 10 percent of its GDP during those three years and sent unemployment soaring to a record 10.9 percent in the last quarter of 2003.

Active tech sector

Already, Israel has more companies traded on the Nasdaq than any other country outside North America. Moreover, annual foreign investment in Israeli startups has consistently outstripped any European country, according to the Israel Venture Capital Association, even though Israel has a population of only 6 million.

Sequoia Capital, one of the first Silicon Valley venture capital firms, has only one office outside the United States -- in Israel. Benchmark Capital's two foreign bases are London and Tel Aviv. Siemens venture capital has said it will open an Israel office -- its only branch outside Europe and the United States.

Last month, investors at VentureWire Network Outlook 2004, an annual trade conference of the U.S. venture capital industry, voted three non-U.S. companies among the 10 startups most likely to succeed. All three were Israeli: Actelis Networks, BitBand and P-Cube.

Among the recent deals was an investment of $20 million by Grove Street Advisors in Pitango Venture Capital on behalf of the California Public Employees' Retirement System.

Last week, the Israeli retail comparison site Shopping.com announced plans to file for the first Nasdaq IPO by an Israeli company in two years.

Grove Street Advisors founder and managing partner Clinton Harris said he has been investing in Israel since 1991 and has returned because now is "a good time to invest."

"We have $500 million earmarked for startups and set aside 5 to 10 percent of that amount for Israel," said Harris. "Apart from Israel, we have almost nothing invested outside the U.S."

Overall economic conditions

Israel's economic indicators are turning positive. Growth projections for the year have been adjusted to 3 percent, while demand, private consumption, sales and output all rose in December and January, according to Israel's Central Bureau of Statistics.

Professor Avi Ben-Bassat of the Hebrew University in Jerusalem, a former director-general of the Israeli Finance Ministry, agreed that there is "a very positive change in the trend of the economy." But he's not totally sold on the turnaround. Israel is "still in deep recession," he said.

"It will take a long time before we reduce unemployment from its current very high level of 11 percent to the natural level of about 6 percent and restore GDP growth to the pre-recession levels of 4 or 5 percent per year," Ben-Bassat said. "But we expect GDP to grow at a rate of 2 to 3 percent this year, which is much better than the negative trend of the past two years."

"Escalating interest in Israeli high-tech companies among foreign investors and the fact that 12 Israeli venture capital funds have embarked on raising new funds are clear signals that the environment has significantly improved." The center forecasts that Israeli VCs will raise between $1.5 billion and $2 billion in 2004-05.

U.S. investors argued that the fall in foreign investment since 2000 was due to global economic conditions, not the intifada. They said they were not deterred by fears of the security situation in Israel.

"I've come here a dozen times, so I'm certainly not concerned about it," said Arjun Gupta of TeleSoft Partners, which has investments in two Israeli companies, Lynx and Jungo.

"I think there's a higher chance that you'll have a wreck on a U.S. freeway than really get into a problem here. Having said that, if you have other people's capital, you have fiduciary responsibility," he said.

"Across the board, we've never had an Israeli entrepreneur not say: 'Hey, if there's any problem, I'll pull the whole company over to the States,' " Gupta said.

The venture environment

Jon Medved of Jerusalem's Israel Seed Partners, a venture capital group with $260 million under management, said he faces growing competition from U.S. funds investing directly in Israeli startups.

"There has been much talk lately in the U.S. of the venture overhang where too much money is chasing too few good deals, but the situation in Israel is still the opposite," Medved said.

"Israeli venture funds like my own are seeing quality deals at reasonable prices which are roughly half the valuations that are prevalent in the U.S. We have actually been outbid on a few deals recently by U.S. funds who felt the prices were attractive enough to pay a significant premium to what we offered, " he said.

U.S. investors say Israel offers a unique mix of entrepreneurial and technological skill, backed by a discipline and frugality that they ascribe to the influence of the army.

"They don't need as much money to get things off the ground here in Israel as they do in the U.S.," said Kellogg of Silicon Valley Bank. "Fear of failure is not an issue here like it is in other parts of the world. If you fail, it's not a bad thing like it is certainly in Europe and in Asia."

Isaac Applebaum of Lightspeed Venture Partners said he has invested in six Israeli companies and is beginning to see the emergence of serial entrepreneurs.

"It's the only place like it," said Applebaum. "I think it's going to get a lot better because there's a lot of new money coming in. These guys work day and they work night, and they deliver."

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Israeli ventures

According to the Israel Venture Capital Research Center, the $1.1 billion attracted by Israeli startups in 2003 meant investment was nearly back to the 1999 level.